I’m beginning to get that spring/summer 2008 feeling again, and it’s no wonder.
The latest GDP report this morning signals that we may be heading into recession again—this time with an unemployment rate above 9 percent. Despite that, the political fight du jour is over just how many trillions of dollars in spending we need to cut—with the Republicans threatening to go nuclear on the debt ceiling, while ruling out any tax increases to reduce the debt they claim to be so worked up about. Europe can’t or won’t get a handle on its bad debts and has a good chance to trigger another financial crisis of unknown dimension. Our own banking system is hardly on solid footing, despite trillions of dollars in direct taxpayer bailouts, subsidies, and guarantees. To make things worse, our governments, fresh off perhaps the biggest financial crisis ever (and I’ve never been convinced that it actually ended), just flat can’t afford another one right now.
The Wall Street Journal reports today that the debt-ceiling fiasco is starting to affect markets and the real economy. Investors have long assumed that Republicans wouldn’t be crazy enough to sink the economy by not agreeing to pay off past obligations, but they’re hedging their bets now, yanking money out of money market funds and increasing the cost of the overnight loans that help finance companies’ day-to-day operations.
The combination is effectively a withdrawal of cash from what has become known as the shadow-banking system, where funds, banks and investors lend and borrow trillions of dollars daily. That cash is now piling into bank deposits, which yield virtually zero but are guaranteed by the Federal Deposit Insurance Corp.
This is not at all yet a run on the shadowing-banking system, but it’s worth watching closely when people start to pull their money out because of jitters about markets as a whole, particularly when the system is fragile.
The Journal reported last night that overnight repo rates—what banks charge to lend short-term against high-quality assets like Treasuries (read a Financial Times explainer here) —have gone from 0.01 percent to 0.1 percent, which is still low, just this week. Bloomberg News reported this afternoon that overnight repo rates jumped to 0.21 percent this morning.
Bloomberg also reports that tremors spread to the mortgage REIT industry, whose stock index plunged by 8.5 percent at one point today before recovering to what was at last check a 2.5 percent drop. Why? Fears over jumping repo rates.
The New York Times reports that as of yesterday investors had pulled $37.5 billion out of money-market funds in the last week.
The Journal says something similar, and says today may be worse:
Investors pulled $9 billion a day out of money funds this week, according Nomura Securities International Inc. The outflows in the past day could be even higher, traders say. Some $62 billion has left money market funds in the past two weeks, according to the Investment Company Institute.
The WSJ should have given us some numbers to put those figures in context. How big is the overall market? How much normally flows in or out in a day or week? The Times does better, reporting there were “daily inflows of $280 million for much of July.” So the market went from an average $280 million inflow a day to an average $9 billion outflow in the last week. And the Times also gets this very good quote from Peter Crane, who runs a company that tracks money-market data, and helps tells us what the numbers mean:
“It’s big, no doubt about it,” he said. “Seventeen billion isn’t a run, but it’s definitely indicative that investors are shifting their assets. If this were to continue for another week or two, it would be very disturbing.”
Across the pond, the Euro crisis doesn’t appear to be abating despite the latest rescue plan for Greece. Paul Krugman writes that:
When I fire up my computer these days, I quickly check out the Italy-Germany 10-year spread. That spread spiked earlier this month, signaling the spread of the crisis beyond the small peripheral economies; at its peak a couple of weeks ago it was 3.32 percent. Then the new rescue plan was announced, and the spread fell to 2.47 — still very bad, but a little less catastrophic.
Well, as of this morning it’s back up to 3.08. Things are falling apart.
Don’t look now, but as of this afternoon—two days later—that spread is at 4.26 percent.
Finally, it’s worth looking at Jonathan Weil’s column from a week ago eviscerating Bank of America’s balance sheet (emphasis mine):
At $9.85 a share, down 26 percent this year, Bank of America finished yesterday with a market capitalization of $99.8 billion. That’s an astonishingly low 49 percent of the company’s $205.6 billion book value, or common shareholder equity, as of June 30. As far as the market is concerned, more than half of the company’s book value is bogus, due to overstated assets, understated liabilities, or some combination of the two.
That perception presents a dangerous situation for the world at large, not just the company’s direct stakeholders. The risk is that with the stock price this low, a further decline could feed on itself and spread contagion to other companies, regardless of the bank’s statement this week that it is “creating a fortress balance sheet.”
None of this, of course, means we’re heading for a crash, but it’s sure not helping anything. And it shows how insane it is to be playing around with something like the debt ceiling. Nobody knows what might happen.